GOLD

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Gold at Home

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uring all the preceding analysis of the workings of our monetary system, gold has appeared to play no role at all. Now, after waiting so long in the wings to determine the ultimate course of the drama, gold steps into the center of the stage.

First of all, until 1968, the volume of Federal Reserve Notes outstanding could not exceed four times Federal Reserve Bank holdings of gold certifi cates, a special form of currency backed 100 percent by gold actually held in the Treasury vaults at Fort Knox. For example, on September 30, 1967, Federal Reserve Notes outstanding amounted to $39.6 billion, against which the Reserve Banks were required to hold $9.9 billion in gold certifi - cates; their actual gold certifi cate holdings on that date were $12.5 billion. This margin of $2.6 billion in excess gold certifi cates was shrinking rapidly, however, as cur- rency in circulation was rising and America ’ s gold stock was shrinking. Thus, a year earlier, the gold certifi cate

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reserve had been $0.3 billion bigger and Federal Reserve Notes outstanding had been $2.0 billion smaller. In other words, we were rapidly approaching a point where we either had to defl ate the money supply or change the law; we clearly chose the lesser of two evils and changed the law.

Indeed, in earlier years, the gold certifi cate reserve requirement had applied against both Federal Reserve Notes and against the deposit liabilities of the Federal Reserve Banks (primarily member bank reserve bal- ances). In 1945, Congress lowered the original reserve requirements that had been set in 1913. Then, in 1964, when our gold certifi cate reserve exceeded the require- ment by less than $2.5 billion the requirement against deposit liabilities was removed by Congress. And now, the gold certifi cate reserve requirement has been eliminated completely.

The original purpose of this legislation was to set an upper limit to the supply of money in the United States by setting a maximum to the volume of commercial bank reserves and to the amount of currency outstanding. Two factors explain its gradual abandonment. First, our levels of economic understanding and sophistication of mon- etary management are so much more advanced today than they were fi fty or sixty years ago that arbitrary bar- riers of this nature are obsolete and can cause more prob- lems than they solve. Second, the original authors of the Federal Reserve Act could hardly visualize the enormous

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expansion in the money supply that is needed to fi nance the operations of an economy as tremendous as ours in this day and age. The law has had to give way to the sheer necessity to have more dollars to fi nance trillions of dol- lars a year of expenditures.

Furthermore, the application of the gold certifi - cate reserve to Federal Reserve Notes alone was hardly an effective way of restraining the money supply. As we have seen, Federal Reserve Notes are not “ issued ” in any active sense of the word — the public draws cur- rency from the banks as they need it. They obtain the currency by cashing checks — that is, by drawing down their demand deposits. This means, in turn, that demand deposits tend to rise fi rst, with an increased demand for currency following later on. Since the level of demand deposits is limited by the balances the banks carry at the Federal Reserve and since the 1964 legislation removed any restriction on the abilities of the Federal Reserve to expand member bank reserve balances, keeping the gold certifi cate reserve requirement against Notes alone was clearly an awkward and unsatisfactory way of trying to limit the supply of money.

But we are still left with one fi nal brushstroke to com- plete this portrait of our monetary system. How does gold actually move into and out of the Treasury and how do the gold certifi cates fi nd their way into the Federal Reserve Banks?

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The answer to this question lies in the unique character of gold, the only commodity we are willing to “ monetize. ” This means that we create new money when we acquire gold — we just print it up and call it gold cer- tifi cates. You don ’ t have to have any money in the bank to buy gold — you just pay for it by printing up those certifi cates, depositing them in your bank account, and then drawing checks against it to pay for the gold. This may sound silly, but it is precisely what the U.S. Government does when it acquires gold.

When we buy anything else, we have to have money in the bank to pay for it. The money the Government spends for intercontinental ballistic missiles, paper clips, cement, wheat, or the salary of a Justice of the Supreme Court has to be raised by taxation or by borrowing. The Government, like everyone else, is prohibited from simply printing money to pay for the things it buys. Like everyone else, the Government must somehow fi nance its expenditures, must some how obtain the funds to replenish its bank account when it falls too low.

Unless, that is, the Government is buying gold. If we attached the mysterious qualities of gold to missiles or paper clips or cement or wheat or Justices of the Supreme Court, the Government could also fi nance its payments for those things by printing up paper money called “ mis- sile certifi cates ” or “ paper clip certifi cates ” and so on. But, thank goodness, we have more important things to do with these objects than to bury them at Fort Knox and

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hold them as a reserve against our currency. So we don ’ t monetize them the way we monetize gold.

The actual process of monetizing gold is simple enough.

Since 1933, only the U.S. Government is allowed to own gold (except for the amounts that we use for jew- elry and other industrial purposes). Americans are even forbidden to own gold outside the national borders of the United States. Furthermore, the United States Government refuses to sell gold to any foreign national except to a for- eign government or a foreign central bank. ^∗

Let us take the case in which the Treasury buys gold from Homestake Mining, the largest company in the busi- ness in this country. The gold comes in the form of small bricks, about the same length and width but only half the height of the usual building brick. Each brick weighs more than 30 pounds. Thus, gold is an extraordinarily dense metal, a small amount of it packing a lot of weight.

A brick of this size brings $ 14,000 to Homestake when it is delivered to our offi cial cookie jar at Fort Knox.

∗ The expression “ central bank ” is a generic term that applies to the institution in each country that exercises the gen- eral functions of the Federal Reserve System in the United States. This is usually the bank that holds the reserves of the commercial banks, that issues all or most of the nation ’ s currency, that holds its gold reserves, and serves as banker for the government.

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As in the case of any other purchase — of wheat or cement or missiles — the Government pays for the gold by issuing a check on one of the Federal Reserve Banks.

Homestake will deposit the check in its own commercial bank account and Homestake ’ s bank will, in turn, send the check to the Federal Reserve Bank for deposit to its reserve account there. The Reserve Bank then reduces the Treasury ’ s balance by $ 14,000. Note that the $ 14,000 outlay by the Government has increased Homestake ’ s account without reducing any other account in the com- mercial banking system. Note, too, that Homestake ’ s bank has gained reserves while no other bank has lost reserves.

In effect, the Treasury ’ s balance at the Federal Reserve Bank has been shifted to a member bank ’ s account. Both the money supply and commercial bank reserves have been increased.

Does this mean that all Government buying leads to an increase in the money supply and to an increase in the reserve balances of member banks? If so, then all Government spending would appear to have an extremely infl ationary impact on the economy.

But we have forgotten that the Government takes money in as well as pays it out. Most of what the Government spends is covered by taxes paid in by indi- viduals and business fi rms; the balance is borrowed.

Therefore, expenditures by the Government from its accounts at the Federal Reserve Banks are continuously offset by receipts of tax money or borrowed money

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that the Government uses to replenish its checking accounts.

Unless, once again, the item purchased happens to be gold. No one has to be taxed, no one has to lend the Government a penny in order to make possible the purchase of a little gold brick worth $ 14,000. The Government replenishes its account at the Federal Reserve Bank simply by printing up $ 14,000 in gold certifi cates and depositing them there, just as it would deposit any other money. That is how the gold is paid for and that is how the gold cer- tifi cates come into the possession of the Federal Reserve Banks. And, therefore, the Government can truly write checks indefi nitely to pay for gold, which it can do for nothing else unless it can raise the necessary funds through taxation and borrowing.

But what happens when the United States loses gold?

What happens when a foreign government decides to cash in some of its dollar balances and take the money out in the form of gold?

Insofar as the mechanics of the process are concerned, everything works precisely in reverse — except for the movement of the gold. The gold moves fi rst from Fort Knox to New York, but the foreign buyer seldom goes to the expense and inconvenience of shipping it across the ocean. It is simply deposited for safekeeping in the vaults of the Federal Reserve Bank of New York, a great mass of a quasi - Florentine palace. There the gold resides, fi ve stories

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underground, protected by an air tight and watertight cylin- drical door, 90 tons in weight. ^∗

When the foreign government receives the gold, it issues a check on its bank account to the order of the U.S.

Government. The Treasury in turn deposits this check at one of the Federal Reserve Banks. The Federal Reserve Bank will reduce the balance on its books to the credit of the bank on which the foreign government drew the check, simultaneously increasing the Treasury ’ s balance on its books. Subsequently, the foreign government ’ s check- ing account at its bank will also be reduced. ^†

So far this transaction has the same effect as any receipt of funds by the Treasury — both reserves and deposits of member banks are reduced and the Treasury ’ s account at the Federal Reserve is increased.

Once again, however, the story with gold is differ- ent. Whereas the Treasury normally takes money in in order either to spend it or to use it to repay debts coming due, the money taken in from the foreign government ∗ Gold held in safekeeping for others is called “ earmarked

gold. ” (In recent years the French government has refused to leave gold on earmark and has gone to the expense of shipping all its gold back to France.)

† The foreign government or central bank may actually pay for the gold from an account at the Federal Reserve Bank, in which case nothing will happen in the commercial bank- ing system. However, the balance that the foreign govern- ment built up at the Federal Reserve Bank had previously been accumulated by withdrawals from commercial banks.

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for the sale of the gold will not be paid out again. Since the Treasury now holds less gold than it held before, gold certifi cates must be withdrawn from the Federal Reserve Banks and cancelled. As a result, the Treasury ’ s balance on the books of the Federal Reserve will drop back to where it was before the gold sale, and the Reserve Banks ’ gold certifi cate reserve will be smaller.

Thus, the movement of gold into and out of the country infl uences the level of business activity here, quite aside from the gold certifi cate reserve requirement, through its effect on the level of member bank reserves. In fact, the movement of gold has in some ways a more profound impact on our economy than the movement of commod- ities that loom much larger in our day - to - day life, such as wheat, whiskey, and automobiles.

Of course, the two movements are intimately related, for the traffi c in gold is in large part determined by the trade in commodities that goes on between the United States and the rest of the world. Gold is, in fact, such a strategic link between the American economy and the world around us that the major reason we abandoned the gold certifi cate requirement against Federal Reserve Notes was precisely because we needed all our gold reserves to sustain our international fi nancial position.

Our next step, therefore, must be to see how gold infl u- ences and is infl uenced by our patterns of trade, investment, and military activity beyond the borders of our own nation.

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Gold Abroad

O

ne nation cannot indefi nitely pay out to foreigners more than it receives from them. This is as true of nations as it is of individuals or cor- porations. You can ’ t spend money you haven ’ t got: there has to be a day of reckoning somewhere along the line, and gold is what nations have used by common consent when the day of reckoning comes. It is, in short, the only unquestioned and generally acceptable means of payment among nations, as dollars are the only unquestioned and generally acceptable means of payment among Americans, francs among Frenchmen, sterling among the British, and so on.

Few people realize, however, that gold ’ s hegemony as the world ’ s sole monetary standard has been surprisingly brief. Britain was the fi rst country to adopt gold as the single monetary standard in 1821, but only after ample supplies of it were discovered in the latter half of the nineteenth century did most other countries follow suit. Yet by merely 1937,

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only about fi fty years after gold had reached its zenith, not one country in the entire world continued to maintain a fi xed tie between its currency and the price of gold, and only a few any longer permitted free and unlimited convertibility of their currency into gold.

The most important metamorphosis through which gold has passed since the fi nancial catastrophes of the 1930 s has been its disappearance from sight. Under the old gold standard, all other forms of money had been freely convertible into gold by all holders at fi xed rates of exchange. But during the monetary collapse that followed 1929, people all over the world lost confi dence in their governments ’ ability to maintain free convertibility into gold. What happened was the one thing that must never happen in a viable monetary system: everybody rushed to ask for conversion. The demand for gold was so much greater than its limited supply that the one thing every- body wanted was denied them and the very reason for the fear was realized: gold convertibility was suspended.

Gold literally went back underground, to be seen only by the privileged few who tend it in the antiseptic vaults that have been dug for it under central banks and Treasuries throughout the world. Even now, when people in many nations (but not Americans or Englishmen) are free to own gold, the owner usually holds just a safekeeping receipt and seldom if ever actually lays eyes on his treas- ured asset. Dubbed “ part of the apparatus of conservatism ” by the most famous economist of the Depression years,

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John Maynard Keynes, because its relatively fi xed supply so rigorously set the upper limit to any expansion in the quantity of money, gold now plays a more subsidiary role and is on the defensive against substitutes whose supply can be more elastic for the settlement of international accounts. This was predicted more than thirty years ago by Keynes, in an eloquent passage from an essay entitled Auri Sacra Fames:

Almost throughout the world, gold has been withdrawn from circulation. It no longer passes from hand to hand, and the touch of the metal has been taken away from men ’ s greedy palms.

The little household gods who dwelt in purses and stockings and tin boxes have been swallowed up by a single golden image in each country, which lives underground and is not seen. Gold is out of sight — gone back into the soil. But when gods are no longer seen in a yellow panoply walk- ing the earth, we begin to rationalise them; and it is not long before there is nothing left.

In the United States, only foreign governments and central banks have the right to convert their dollars into gold. In fact, the average American has little or no aware- ness of gold ’ s existence. He knows that we have a hoard of it out at Fort Knox, and that the hoard has been shrinking.

He suspects this means something is amiss, but he neither

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knows what is amiss nor can he work up much concern about it.

But something is indeed amiss, and it is important to us. For, in recent years, our gold stock has not only been shrinking, but the claims that entitle foreign countries to ask for more of it have been increasing. If the claims grow too large or if our gold stock falls too low, our for- eign friends may ask for gold from us, not because they need it to settle up their own international accounts, but simply because they want to be sure to get what is com- ing to them before we shut down the doors on it. Like all bankers, the United States is able to satisfy withdrawals by some of its depositors some of the time but cannot satisfy withdrawals by all of its depositors at the same time.

How did the richest country in the world, holding three quarters of the world ’ s stock of monetary gold at the end of World War II, ever get into such a position? The expla- nations for diffi culties are easier to fi nd than the cures: the United States has simply been paying out to foreigners more than foreigners have been paying to us.

This does not mean that we have been importing more than we have been exporting — on the contrary, our balance of trade has remained highly favorable to us.

Our commercial exports of goods and services in 1966, for instance, were at a record high of $36 billion; they exceeded our commercial imports by $2 billion.

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